Question

You are considering the purchase of several bonds and are concerned about the sensitivity of the bonds in what you believe will be a volatile marketplace for several years.

1. If two bonds being considered each have a coupon of 7% but one matures in 20 years and one in 25 years, which will be more sensitive to changes in interest rates?
2. If two bonds being considered each have a maturity of 20 years but one has a coupon of 7% while the other has a coupon of 8.5%, which will be more sensitive to changes in interest rates?

Answer 1

We know that the bond price is the sum of present value of coupon expected on bonds and its maturity value.

a)Bonds with higher maturity period is more sensitive to change in interest rate as the higher period means lower present value.Thus if two bonds have same coupon rate of 7% but different maturity period,then bond with hifher maturity period is more sensitive to change in interest rate(Discount rate).

Accordingly,bonds with maturity period of 25 years shall be more sensitive.

b)Bonds having lower coupon rate is more sensitive to change in interest rate.Again the reason is discounting.Thus bonds with coupon rate of 7% shall be more sensitive to change in interest rate.